I thought it would be nice to take a break from sounding like one of Plato's lesser-known, even-more-evil competitors, and note the latest in the eternally fascinating and bizarre gold-dollar system.

In the dollar's favor, gold lease rates appear to have stabilized. (Ie: either this signal was only a glitch, perhaps due to LIBOR weirdness, or it was countered effectively by policymakers). Moreover, as expected in a recession, true jewelry consumption has crashed.

In the East, at least, it is hard to separate luxury from investment jewelry, but even gold investors of the Oriental persuasion seem to operate on an intrinsic-value theory: they feel that the stuff has some natural price as a commodity, and they tend to buy when it is cheap and not when it is not. As we have seen, this is not rational - the rational gold investor is a momentum investor. However, this demand pattern is real and unlikely to change any time soon.

And "Western investment demand" is keeping the gold price in dollars relatively high. Perhaps a more accurate description is perhaps capital flight to gold - or, here at UR, moving to Moldenstein. To paraphrase Milton Friedman, perhaps it's just obvious that you can't have a heavily-bleeding global reserve currency and a free market in the precious metals.

Of course, as per the paradoxical logic of monetary commodities, this is true only if everyone knows it. Perhaps you are familiar with the paradox (familiar to every CTY veteran) of the blue-eyed islanders. As we enter 2009 there is a simple, mechanical trigger analogous to the stranger's arrival: any dumb, statistical screen for financial assets that outperformed in 2006, 2007 and 2008 will put gold somewhere near the top of the page. Moreover, it is obvious that the market for monetary gold is anything but saturated - even most rich people still have none. Doh.

So, while it appears to me from my cursory perusal of the mainstream press, that more people are beginning to understand gold, readers should bear in mind that (a) this too might be a glitch; (b) the debt market is a Rube Goldberg machine which may suddenly, if enough gasoline is poured into it and a sufficiently large blowtorch is applied, restart for no obvious reason; (c) even if people understand things, they can subsequently be made to un-understand them; and (d) the fact we continue to have a free market in said precious metals is a function not of USG's wisdom, but of its weakness - a quality never to be relied upon in one's enemies.

That said, the statistics for early 2009 are fairly impressive. Gold flow into the SPDR trust alone, for example, is at almost 200 tons for the last month. Ie: six billion dollars. Ie: roughly equal to planetary gold production. On February 11th and 12th, the flows were 40 and 35 tons - a billion dollars a day. This is almost real money. (Briefly: gold flows into to the trust when, if gold did not flow into the trust, the price of SPDR gold would exceed the futures-market price.) Furthermore, while God only knows what they are backed with, precious-metals bank accounts are reportedly proliferating in Russia.

This trend is not sustainable at its present level. It must either accelerate, or terminate. In retrospect, it will look like either a real signal, or a real glitch.

If the latter, the gold price carries a heavier monetary premium than at any time since 1980 - at least. It has more monetary support and less support from the traditional market, ie Hindu brides, and it will collapse more sharply. Gold can flow out of monetary caches, as well as in. Just so ya know. (And besides, it is always a contrary indicator when UR mentions gold.) In retrospect, it will look as if gold has experienced another 1980 bubble and collapsed.

If the former, it will look like Exter's pyramid has finally rolled tip down. This, like everything, will appear obvious and inevitable in retrospect. (There is probably no one at the New York Fed who remembers John Exter, but I'm sure his collected memos remain in the files.) I would not be surprised to see some political changes accompany any such monetary earthquake.

Computing any level for a fully-monetized gold price is number abuse. Gold price in what? By definition, your denominator has gone AWOL. However, perhaps a ballpark guess can be constructed by comparing annual global gold production, which while elastic is not as elastic as one might think, to annual global savings.

Certainly, until incremental monetary demand is consistently absorbing all new production, the gold rocket is still, in some sense, sitting on the launch pad. And so it is. There is some steam or something, however, emerging from the base. Either this is nothing, or it means the rocket is about to take off, or it means the rocket is about to fall over and blow up. It's your call, dude.

32 Comments:

perhaps a ballpark guess can be constructed by comparing annual global gold production, which while elastic is not as elastic as one might think, to annual global savings.

For the curious:

The world's savings rate is apparently about 26%. (See chart 1b in http://cib.natixis.com/flushdoc.aspx?id=44888.)That number is an average of savings "as a percentage of GDP". It includes all kinds of savings, including individuals, corporations, and governments.

leonard's comment is why I don't stress over the fluctuations we've seen in the last year. I'll be putting a significant percentage of my income into gold regardless of what the price does over the next few years. If it drops back to 1960 levels? well I'm no worse off than the people who waste their money on crap they don't need. And the upside is, as mentioned, ridiculous.

What are the odds that gold moneterizes and that the USG sovcorp doesn't decide that plainlanders can't hold gold? Or that when my broker goes under that I actually have a secure claim on the gold equivalent of my shares?

In short, doesn't the exact scenario by which I become fabulously wealthy preclude my keeping the proceeds?

Leonards figures are very useful. 170,000 dollars an oz. is as much a reason to think gold will in fact not become a world currency proxy as it is to think it would be. All that is gold does not glitter. And, those who repeat their history are doomed to remember it: Roosevelt (The Great) campained in 1932, committed to the gold standard under the Democrat Party platform, which said 'to suggest the Democrat Party might be driven off the gold standard was a political indecency, and not far short of treason; and that for the Government to engrave the words, "Payable in gold coin of the present standard of value" on the face of its bonds and notes and certificates of indebtedness and sell them to investors while knowing that the gold standard was in danger would be an act of amazing dishonesty.'

That is exactly what they did. On May 1, 1933, it was a crime to have in possession more than $100 in gold or gold certificates.

I've been building a (very) small gold cache over the last few months--just an ounce a paycheck, as a secondary savings mechanism. I'm actually buying physical coins, as this is mostly a SHTF measure, not speculation, and I have no faith that even a gold account at a bank will be redeemable, let alone something as nebulous as an ETF, if and when the SHTF.

Don’t you think it is about time GLD and all the other popular international gold ETFs told its owners exactly what kind of gold they claim to own?

Can you imagine a situation where a person buys a gold ETF to own “non-gold” but finds out that they in reality own OTC derivatives on gold? That would be an investment in the same type of financial instrument (not gold) that one owns gold bullion to protect against.

The failure to unearth the Madoff scandal becomes incredible when one understands that the returns from the market claimed on the size of the hedge fund were logically impossible.

The exact same reasoning screams bloody murder when applied to the many Gold EFTs in terms of what it is they really own.

This begs one major question: From where did all the gold claimed to be owned by all the gold ETFs come from?

Where did funds such as GLD get their additional 45 tons in the last month?

We certainly can forget about that gold coming from the Comex. 12 deliveries would stand out like a sore thumb.

This concept and record keeping eliminates all exchanges around the globe as the source of bullion delivery in any size to all Gold ETFs.

The physical market is so tight that coin minting has all but closed down compared to what it was one year ago. It is hard to accept that the Gold EFTs can buy what the mints can’t."

Platinum is said to be a precious metal, but it seems cheap if that's true considering the price of gold and platinum's greater rarity. Maybe platinum isn't a precious metal, but it was used as money in the USSR of all places. Platinum was dumped as people ran into US$. Will people ever demand platinum as money beyond a title of higher-status in advertisement? At one point platinum even traded below gold. The market rewards the better forecaster of demand, and I like this bet.

"I've been building a (very) small gold cache over the last few months--just an ounce a paycheck, as a secondary savings mechanism. I'm actually buying physical coins, as this is mostly a SHTF measure, not speculation, and I have no faith that even a gold account at a bank will be redeemable, let alone something as nebulous as an ETF, if and when the SHTF."

A good idea. Get some silver too, I like Maple Leaves. They might be useful "small change" so to speak. But also stock up on brass and lead, if you get my drift. If the S ever does HTF, keep the brass for yourself, but anybody looking for trouble gets the lead and plenty of it. See you in the streets!

i may diversify into silver if i can find anyone around here selling it at a sane markup. (i'd have bought platinum three months ago when it was at par with gold, but i couldn't find it except at collectors rates, ~spot+80%)

alternatively, there's gold small change--bullion is available at least down to .1 oz (or even smaller, 1 gm, if you prefer the pamp bars), and possibly .05 oz

You can't depend on the blue-eyed islander phenomenon to predict behavior because apart from the fact that people aren't perfectly logical, the logic is flawed:

The problem with this puzzle's solution is that it assumes everyone sees everyone at the same time.

You cannot say for certainty that the suicide/departure will happen in k+1 days time because, even though the islanders have perfect knowledge of each others' eye color (once seen), they likely haven't already seen all of them.

Now, if they've seen everyones eye color, then they'll all leave/kill themselves on the second day.

That first day Tom will think "well, there goes Bob and Joe and Carl -- it was nice knowing them." But when Bob and Joe and Carl don't off themselves in the morning, Tom will realize that he is also blue eyed (everyone else being brown eyed) and join the merry immolation throng in the morning.

No -- either they already know everyone else who has blue eyes or they don't.

If they don't, then it won't happen at k+1 because there can be no way to systematically see everyone -- indeed, the more logical (the ones who don't want to off themselves) will try to avoid eye contact -- i imagine an uptick in the sale of dark sunglasses and contacts.

If they already do, they just have to wait for the next day to include themselves (since all the other blue eyed folks are still alive, they must also be blue-eyed).

what are you talking about, everyone stands in a big circle and can see everyone elses eyes. This isn't a problem about motivations. It is a pure inductive logic riddle. the formulation of the problem that involves them getting off the island deals with your objection.

Palmer, you don't seem to be making fun of the blue-eyed islander thing, but you should be.

Actually the logic is airtight, assuming that every person, for some reason, does a full census of everyone else's eye colour. (A bit like Victorians being obsessed with other people's sex lives, I guess.) If you have a specific question about this I'll be happy to try to answer it.

However it's completely true that it's not very handy for the real world. We don't do censi. We do wear sunglasses. The vagueness changes the equation completely. The only solid reason to work out this puzzle is curiosity.

Specifically, it should be mocked by bringing in real-world considerations to pick out all the hidden assumptions, until you have a tidy heap of the ridiculous.(Putting that in words was actually pretty hard, which surprised me.)

Also the real world has no hard feedback like ritual suicide. That would be the first change I'd make to better approximate reality; instead of publicly doing anything, they would privately rotate a certain decoration by pi/2. This is the situation we're used to dealing with which is why our brains don't naturally follow such logics.

The puzzle itself is an example of how the truth is a high-entropy state. Lots of logicians gets lots of answers, but over time it settles into the right answer. It would be nice if someone could quantify countervailing processes that out-compete this one.

It can't happen on day two because everyone is waiting for the day corresponding to the number of blue eyeds they see.

The blue eyeds see 99, and assume they'll all off themselves on day 99. The brown eyes are waiting for day 100, and indeed find that on day 100 they all off themselves, the days having exceeded the number of blue eyeds they can see.

And then, unless other eye colours are possible, all the brown eyeds learn they have brown eyes and immediately off themselves.

Presumably the visitor then grows a rocket and flies to the moon, because that's about as real-world likely as all the other assumptions.

That puzzle is more a trick than anything else, in its implicit assumption that the islanders have not already killed themselves. Any event which causes them to think about eye-color should, according to the unrealistic assumptions in the puzzle, "start the clock" ticking towards their doom. So it could have happened in any previous meeting of the tribe, and the precipitating remark could be almost anything. (Presumably they all think exactly alike, or else they cannot be assured everyone else has noticed and started the doom-clock.)

You might think that the islanders would have devised ways to prevent the doom-clock from starting, which is true enough. All they need to do is avoid meeting together all together, enough so that everyone knows what the eyecolor counts are, and that everyone else knows them. But then, again, we have the scenario smuggling in the opposite: they have all met together to listen to the visitor. You'd think that people smart enough to do mass-induction proofs (and so smart that they all know everyone else will do such proofs), would be clever enough to avoid going to any mass meeting.

As it relates to gold, though, the scenario is more realistic. There have been good reasons why this "tribe" has never yet "met". Of course most of the players in the market are dumb as rocks; induction is not part of what we're talking about. The applicable part of the analogy is the sense that the transition from dollars to gold is essentially a phase change, that could happen at any time, with the tiniest precipitating event. It's like a supercooled bottle of water, waiting for a seed. When it does start, you can be sure that the mass media pound it into everyone (just as with all previous bubbles).

If you want an example of the Cathedral redefining things, now that the government is taking more and more of the marketplace, Harvard is also having a conference on free markets with all sorts of academic justifications as to why they are bad for society. Take a look at the Schedule.

Wonderful to hear Exter's name and to read the interview. I have a typewritten copy of a speech he gave back in the late '70's. He was the first person whose ideas made sense to me, when I was puzzling through what was up in the 70's inflation. I understand that he was friends with Von Mises and his wife.